Tax Court in Brief September 5 – 11, 2020

The Tax Court in Brief September 5 – 11, 2020

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

The Week of September 5 – September 11, 2020

• Sutherland v. Comm’r, 155 T.C. No. 6
• Fowler v. Comm’r, 155 T.C. No. 7
• Robert J. Belanger v. Comm’r, T.C. Memo. 2020-130
• Korean-American Senior Mutual Association, Inc., T.C. Memo. 2020-129 

Sutherland v. Comm’r, 155 T.C. No. 6

September 8, 2020 | Lauber, J. | Dkt. No. 3634-18

• Opinion

Short Summary:  In 2010, Ms. Sutherland’s husband was indicted for tax crimes.  He pled guilty, and as part of his plea agreement, he was required to submit delinquent tax returns for 2005 and 2006 (among other years).  Ms. Sutherland signed the returns for 2005 and 2006.

Later, Ms. Sutherland filed an IRS Form 8857, Request for Innocent Spouse Relief, for 2005 and 2006.  The IRS reached a preliminary determination to deny her request for innocent spouse relief, and she appealed.  During the IRS Appeals process, Ms. Sutherland’s attorney determined that the Appeals Officer (AO) was not properly applying the innocent spouse factors.  Because no progress was being made, her attorney chose not to submit additional evidence on the belief that Ms. Sutherland would receive de novo review in the Tax Court.

During the Tax Court proceedings, Ms. Sutherland filed a motion to remand, arguing that the amended scope of review under Section 6015(e)(7) would disadvantage her by preventing her from introducing additional evidence outside the IRS administrative record.  The IRS opposed the motion, contending that remand is not permitted in a stand-alone innocent spouse case.

Key Issue:  Whether the amendments to Section 6015(e)(7) apply to Ms. Sutherland’s case?

Primary Holdings: 

• The Congressional amendment to Section 6015(e)(7) is effective for petitions filed in the Tax Court on or after July 1, 2019; the amendment to Section 6015(f)(2) is effective for requests pending in the IRS on or after that date. Because Section 6015(e)(7) does not apply in this case (as the petition was filed prior to July 1, 2019), the scope and standard of review will be de novo.

Key Points of Law:

• Married taxpayers may elect to file a joint federal income tax return. 6013(a).  After making this election, each spouse is jointly and severally liable for the entire tax due for that year.  Sec. 6013(d)(3).
• Section 6015(b) specifies general procedures for relief from liability, and subsection (c) specifies procedures to limit liability for taxpayers who are no longer married or are living separately. Section 6015(f)(1)(B) provides that “equitable relief” may be afforded to a taxpayer if “relief is not available to such individual under subsection (b) or (c).”
• Under procedures prescribed by the IRS, Section 6015(f) relief may be available if taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency (or any portion of either).” 6015(f)(1)(A); Treas. Reg. § 1.6015-4(a).  The Commissioner has specified procedures governing equitable relief.  Rev. Proc. 2013-34, 2013-43 I.R.B. 397.  Relevant factors include (among others) the requesting spouse’s marital status, knowledge about information on the return, and mental or physical health.  Id. sec. 4.03(2), 2013-43 I.R.B. at 400-403. The mental or physical health factor is evaluated as of the time the return was filed.  Id. sec. 4.03(2)(g), 2013-43 I.R.B. at 403.
• Section 6015(e) permits a taxpayer who is denied innocent spouse relief to file a petition for review in this Court. “Such cases are referred to as ‘stand alone’ cases, in that they are independent of any deficiency proceeding.”  Davidson v. Comm’r, 144 T.C. 273, 273-274 (2015).  As originally enacted Section 6015 did not prescribe the scope or standard of review for equitable relief claims under subsection (f).  Before 2006 we generally reviewed denial of relief for abuse of discretion.  See Butler v. Comm’r, 114 T.C. 276, 291-92 (2000).  However, following amendments to Section 6015 in 2006 we decided that the proper scope and standard of review were de novo.  See Porter, 132 T.C. at 206-210.
• In 2019 Congress made two amendments to Section 6015, both of which concerned claims for equitable relief. Act sec. 1203(a)(1) added section 6015(e)(7) to the Code.  Captioned “Standard and Scope of Review,” it was designed to clarify the scope and standard of review in this Court, which had been the subject of differing appellate precedent.  See R. Rept. No. 116-39, at 40 (2019).  Section 6015(e)(7) provides that any review of a determination made under this section shall be reviewed de novo by the Tax Court and shall be based on the administrative record established at the time of the determination, and any additional newly discovered or previously unavailable evidence.
• Act sec. 1203(a)(2) added subsection 6015(f)(2) to the Code. Captioned “Limitation,” it provides that a request for equitable relief under this subsection may be made with respect to any portion of a liability that has not been paid, provided that such request is made before the expiration of the applicable period of limitation under Section 6502, or has been paid, provided that such request is made during the period in which the individual could submit a timely claim for refund or credit of such payment.
• Act sec. 1203(b) specified that these amendments “shall apply to petitions or requests filed or pending on or after the date of the enactment of this Act.”
• Under the canon against superfluity, in deciding on the proper interpretation of statutory text “[i]t is our duty to ‘give effect, if possible, to every clause and word of a statute.’” Duncan v. Walker, 533 U.S. 167, 174 (2001) (quoting S. v. Menasche, 348 U.S. 528, 538-39 (1955)).  We are thus “’reluctan[t] to treat statutory terms as surplusage’ in any setting.”  Id. (quoting Babbitt v. Sweet Home Chapter, Cmtys. for a Great Ore., 515 U.S. 687, 698 (1955)).
• The Tax Court has previously declined to remand stand-alone innocent spouse cases under Section 6015(f). See Friday, 124 T.C. at 221-22.  In addition, a request for remand may be denied where the remand would serve no useful purpose.  Burke v. Comm’r, 124 T.C. 189, 194 n.5 (2005) (declining to remand a CDP case because a remand would not be productive); Whistleblower 23711-15W v. Comm’r, T.C. Memo. 2018-34 (declining to remand a whistleblower case because a remand would serve no useful purpose).

Insight:  The Sutherland decision demonstrates the potential traps a taxpayer may have to go through with respect to requests for innocent spouse relief.  Because of the amendment to Section 6015(e)(7), taxpayers should ensure that they provide all helpful evidence to the IRS during the administrative review of their claim.

Fowler v. Comm’r, 155 T.C. No. 7

September 9, 2020 | Greaves, J. | Dkt. No. 12810-18

• Opinion

Short Summary:  On or before April 15, 2014, Mr. Fowler filed IRS Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, extending the due date to file his 2013 IRS Form 1040, U.S. Individual Income Tax Return, until October 15, 2014.  On October 15, 2014, Mr. Fowler attempted to e-file his 2013 Form 1040.  Although the IRS received the e-filing, it issued a rejection notice for failure to provide a valid Identity Protection Personal Identification Number (IP PIN) with the e-filed return.

Thirteen days later, on October 28, 2014, Mr. Fowler mailed the 2013 Form 1040 to the IRS.  The IRS received the return on October 30, 2014.  However, because Mr. Fowler received a letter in December 2014 notifying him that the IRS had not received his 2013 return, he e-filed his 2013 Form 1040 on April 30, 2015.

On April 5, 2018, the IRS issued Mr. Fowler a notice of deficiency.  Mr. Fowler timely filed a petition with the Tax Court and raised the affirmative defense of the statute of limitations.

Key Issue:  Whether the statute of limitations for assessment expired prior to the IRS issuing the notice of deficiency to Mr. Fowler.

Primary Holding: 

• Because Mr. Fowler’s submission on October 15, 2014, was a “required return” and “properly filed,” the statute of limitations for assessment expired before the IRS issued the notice of deficiency.

Key Points of Law:  

• The purpose of summary judgment is to expedite litigation and avoid costly, unnecessary, and time-consuming trials. See FPL Grp., Inc. & Subs. v. Comm’r, 116 T.C. 73, 74 (2001).  We may grant a motion for summary judgment, or partial summary judgment regarding an issue, when there is no genuine dispute of material fact and a decision may be rendered as a matter of law.  Rule 121(b); Arts, Inc. & Subs. v. Comm’r, 118 T.C. 226, 238 (2002).  Furthermore, we construe the facts and draw all inferences in the light most favorable to the nonmoving party to decide whether summary judgment is appropriate.  Sundstrand Corp. v. Comm’r, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7^th Cir. 1994).
• Section 6501(a) generally requires that the IRS assess tax within three years after the taxpayer filed his or her return. This three-year period begins on the due date of the return if it is timely filed or on the actual filing date if the return is filed late.  See 6501(b)(1).  The statute of limitations on assessment is “an almost indispensable element of fairness as well as of practical administration of an income tax policy.”  Rothensies v. Elec. Storage Batter Co., 329 U.S. 296, 301 (1946).  It assures taxpayers who file honest returns that after that period their tax liabilities will not be reopened.  Mabel Elev. Co. v. Comm’r, 2 B.T.A. 517, 519 (1925).
• The filing of a return commences the running of the limitations period if (1) the document that the taxpayer submitted was a required return, and (2) the taxpayer properly filed the return. Appleton v. Comm’r, 140 T.C. 273, 284 (2013).
• Section 6501(a) explains that “the term ‘return’ means the return required to be filed by the taxpayer”. Neither the statute nor the regulations thereunder expand on this definition.  Given the lack of regulations, this Court generally relies on the test in Beard v. Comm’r, 82 T.C. 766, 777 (1984), aff’d, 793 F.2d 139 (6^th 1986), to determine whether a document constitutes a return.  See Hulett v. Comm’r, 150 T.C. 60, 81 (2018).  The Beard test requires that:  (1) the document purport to be a return and provide sufficient data to calculate tax liability, (2) the taxpayer make an honest and reasonable attempt to satisfy the requirements of the tax law, and (3) the taxpayer execute the document under penalties of perjury.
• Despite the authority delegated in Section 6061, there is little regulatory guidance as to what constitutes a valid signature. Reg. § 1.6061-1(a) provides only that each individual “shall sign” his income tax return.  Treas. Reg. § 1.6695-1(b)(2) directs a signing tax return preparer to “electronically sign the return in the manner prescribed by the Commissioner in forms, instructions, or other appropriate guidance.”
• A “return” by itself does not trigger the statute of limitations; the return must be “properly filed”. Appleton v. Comm’r, 140 T.C. at 284.  The filing requirement is not premised on whether the IRS is informed; e., it is not a question of what the IRS received and understood.  Vento v. Comm’r, 152 T.C. at 15-16.  Instead, a filing issue is generally a question of whether the taxpayer’s mode of filing complied with the prescribed filing requirements.  Id.
• In general, a return is “filed” when it has been physically delivered to the correct IRS office. See Section 7502; Allnutt v. Comm’r, 523 F.3d 406, 412-13 (4^th 2008), aff’g T.C. Memo. 2002-311; Miller v. U.S., 784 F.2d 728, 730 (6^th Cir. 1986).  We have held in Blount v. Comm’r, 86 T.C. 383, 387-88 (1986), that a document that qualifies as a return under the Beard test is filed upon delivery, even if the IRS does not accept or process the document.

Insight:  The Fowler decision is a huge win for the taxpayer and may have an impact on other tax e-file cases, such as those in which the IRS asserts late-filing penalties after the rejection of timely e-filed return.

Korean-American Senior Mutual Association, Inc., T.C. Memo. 2020-129 

September 9, 2020 | Leyden, D. | Docket No. 21829-17X

• Opinion

Short Summary:  Petitioner sought a determination from the Tax Court that Korean-American Senior Mutual Association, Inc. (“KASMA”) was operated exclusively for one or more exempt purposes as set forth in section 501(c)(3).  The Petitioner requested a declaration from the Tax Court pursuant to I.R.C. § 7428(a)(1)(A).

Key Issue:  Was KASMA was operated exclusively for one or more exempt purposes as set forth in section 501(c)(3)?

Primary Holdings: 

• KASMA was not operated exclusively for one or more exempt purposes as set forth in section 501(c)(3).

Key Points of Law:

• Section 7428(a)(1)(A) confers jurisdiction on the Tax Court to make a declaration in a case of actual controversy involving a determination by the Secretary with respect to the initial qualification or continuing qualification of an organization as an organization described in section 501(c)(3) which is exempt from tax under section 501(a). This includes a revocation or other change in the qualification of section 501(c)(3) organization.
• Section 501(a) generally exempts from taxation an organization described in subsection (c). Section 501(c)(3) describes a qualifying organization in relevant part to include “[c]orporations . . . organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes.” An organization that qualifies under section 501(c)(3) not only is exempt from Federal income tax but also may solicit and accept donations which are normally deductible by the donor against his or her federal tax.
• The standard for tax-exempt status prescribed in section 501(c)(3) requires that an organization be “operated exclusively” for an exempt purpose. Reg. § 1.501(c)(3)-1(c)(1) provides an operational test to determine if an organization is operated exclusively for an exempt purpose.  “(c) Operational test–(1) Primary activities.–An organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.” Reg. § 1.501(c)(3)-1(c)(1).  In other words, the presence of a single substantial purpose that is not described in section 501(c)(3) precludes exemption from tax under section 501(a) regardless of the number or the importance of the purposes that are present and described in section 501(c)(3).
• “Under the operational test, the purpose towards which an organization’s activities are directed, and not the nature of the activities themselves, is ultimately dispositive of the organization’s right to be classified as a section 501(c)(3) organization.” S.W. Grp., Inc. v. Commissioner, 70 T.C. 352, 356-357 (1978).
• When an organization conducts a business in a commercial manner, that fact weighs heavily against exemption. “The particular manner in which an organization’s activities are conducted, the commercial hue of those activities, competition with commercial firms, and the existence and amount of annual or accumulated profits, are all relevant evidence in determining whether an organization has a substantial nonexempt purpose.”  Living Faith, Inc. v. Commissioner, 950 F.2d 365, 372 (7th Cir. 1991).
• When an organization engages in a substantial fee-for-service or other business activity and the activity does not further the organization’s exempt purpose, the organization is not operated exclusively for an exempt purpose.
• An organization is not operated for an exempt purpose unless it serves a public rather than private interest.

Insight:  The Korean American case illustrates the requirements for an organization to maintain tax-exempt status. Specifically, this case sets forth the operational test that the Tax Court uses to analyze whether an organization is indeed operating under an exempt purpose, and it demonstrates possible issues for tax-exempt taxpayers that engage in fee-for-service or other business activity.  The question of whether an organization has maintained tax-exempt status can be highly complex and is based on the facts and circumstances of each case.

Robert J. Belanger v. Comm’r, T.C. Memo. 2020-130

September 10, 2020 | Ashford, J. | Dkt. No. 25036-14

• Opinion

Short Summary:  The case involved the determination of the statute of limitation for a notice of deficiency sent in 2014, the assessment of additional income and the imposition of civil fraud penalties in a case where the taxpayer was guilty of corruptly endeavoring to obstruct and impede tax laws, by concealing his income, for the tax years 1999 and 2000.

Mr. Belanger (the “taxpayer”) founded Number One Foundations, an unincorporated business back in the 70’s dedicated to provide construction services. Since its inception and during 1999 and 2000, the taxpayer engaged substantially in work related to this enterprise, additionally, the address of the business was the same as the taxpayer’s address. The taxpayer’s son, Steven, handled some operational aspects of the business, such as bank accounts, paying payroll and maintaining business insurance.

The taxpayer did not have a specific bookkeeping system for his business but rather he used the stairs of his house to keep track of the income received from his jobs (the system involved using the lower steps for initial jobs and the upper steps for finished or paid projects). The payments received by the taxpayer usually were in check. Once the payment was received, the taxpayer cashed the checks or negotiated them for treasurer’s checks payable to him. Despite that taxpayer’s business gross receipts for 1999 and 2000 were over $1M, the taxpayer only declared income for less than $100k for each year. It must be added that the taxpayer did not provided any type of supporting documentation to his accountant.

In 2006, as a result of an investigation carried by the IRS in regard to the negotiation of treasurer’s checks by the taxpayer and the origin of the funds used to acquire such checks, the taxpayer was indicted on counts of filing false and fraudulent returns for 1999 and 2000. The indictment alleged that these returns underreported the gross receipts of the taxpayer’s business.

In 2009, the taxpayer was found guilty of corruptly endeavoring to obstruct and impede tax laws and was required to submit a complete and amended Federal income tax return for the 1999-2000 period. The amended returns only reported an increase of gross receipts attributable to the checks payable to the taxpayer. The IRS determined that the returns were inaccurate because they omitted to allocate to the taxpayer the total business’ gross receipts. The IRS sent a notice of deficiency in 2014 reflecting the allocation of the taxpayer’s unincorporated business gross receipts to the taxpayer and the imposition of section 6663(a) civil fraud penalties. The taxpayer disagreed and filed a protest, which the IRS sustained.

The Tax Court analyzed three topics: (i) whether the IRS was barred from assessing income tax deficiencies for 1999 and 2000 on the notice of deficiency issued in 2014, (ii) whether the unincorporated gross receipts should be allocated to the taxpayer and (iii) the imposition of civil fraud penalties. The Court ruled that the IRS was indeed free to determine the deficiency, that the gross receipts of the business should be allocated to the taxpayer and finally, sustained the imposition of civil fraud penalties.

Key Issues:  (i) Whether the IRS was barred from assessing income tax deficiencies for 1999 and 2000 on the notice of deficiency issued in 2014. (ii) Whether the unincorporated gross receipts should be allocated to the taxpayer. (iii) The imposition of civil fraud penalties.

Primary Holdings: The statute of limitations to assess a deficiency is not applicable in cases where the underpayment is due to fraud and the IRS may assess such deficiency beyond the general three-year rule. To impose penalties provided in section 6663(a), the IRS must prove that there is an underpayment, it must comply with the requirements of section 6751(b) and show that the that underpayment is due to fraud.

Key Points of Law:

(i) Statutory period of limitations to assess tax.

Section 6501(a) provides the three-year general rule that requires the IRS to assess a deficiency in income tax after the return was filed. Section 6213(a) requires the IRS to assess a notice of deficiency before assessing the deficiency. Hence, the IRS is allowed to issue a notice of deficiency only within three years.

However, in cases were the underpayment is due to fraud, the Court has ruled that the IRS is free to determine a deficiency without regard to the three-year period of limitations. Consequently, the Court considered that the notice of deficiency issued in 2014 was timely.

(ii) Unreported business income.

When the taxpayer does not have books or record that reflect income clearly, the IRS is allowed to reconstruct income and is allowed to use a method that reflects the full amount of income received. Such method needs only to be reasonable under the facts and circumstances.

The IRS used the “specific item method”, a Tax Court-approved method, that allows the IRS to use evidence of specific amounts of income received by the taxpayer and not reported on his return. The Court considered that because the taxpayer received checks on behalf of his unincorporated business, and he actively controlled and managed such enterprise, the checks were to be reported as part of his gross income.

(iii) Civil fraud penalties.

Section 6663(a) establishes a penalty equal to the 75% of any underpayment of tax that is due to fraud. To assess such penalty, the IRS bears the burden of proof, and must prove that there is an underpayment and that such was due to fraud. To satisfy the first requirement, the IRS must prove a likely source of the unreported income or disprove the nontaxable source so alleged. As part of this first prong of the test, the IRS must comply with the requirements of section 6751(b). To meet the second element, the IRS must show the taxpayer’s intention to conceal or evade the collection of taxes.

In the instant case, the Court ruled that the IRS had complied with section 6751(b) given the fact that the 30-day letter issued by the IRS, which constituted the initial determination of the penalties, was approved by the Revenue Agent supervisor. The taxpayer did not provide any other evidence to disprove this conclusion. Accordingly, the IRS complied with section 6751(b).

As for the two elements of the test required by section 6663(a), the Court analyzed the circumstances surrounding the case, and considered that there was a clear underreporting of business income as shown clearly by the increase of gross receipts attributable to its enterprise.

Finally, to determine whether such understatements of income were due to fraud, the Court ruled that that there was an intentional wrongdoing by the taxpayer motivated by the specific purpose of avoiding tax. To determine the existence of fraud the Court may consider various facts such as: (1) a pattern of understating income, (2) failing to maintain adequate records, (3) offering implausible or inconsistent explanations of behavior, (4) concealing income or assets, (5) dealing in cash, (6) providing incomplete or misleading information to his or her tax return preparer, (7) filing false documents, including filing false Federal income tax returns, (8) failing to file Federal income tax returns, (9) failing to cooperate with tax authorities, and (10) engaging in and attempting to conceal illegal activity.

In the particular case, the taxpayer intentionally concealed income, made payments “under the table”, failed to disclose the full extent of his business income and provided incomplete and misleading information to his accountant. Consequently, the Court determined that the taxpayer’s actions were purposeful, which were confirmed by him being found guilty of impeding tax laws.

Insight:  This case states very clearly some of the implications in cases where fraudulent actions are present. The IRS authority to assess additional tax beyond the general statute of limitations and the imposition of civil penalties are severe consequences that any taxpayer should consider carefully when engaging in transactions that may encompass an element of fraud.

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